EU Emissions Trading System (ETS)

Cap-and-trade system pricing carbon emissions from power generation, industry, aviation, and maritime shipping in the EU.

Launched in 2005, the EU Emissions Trading System is the world's first and largest international carbon market, covering approximately 40% of the EU's total greenhouse gas emissions. Operating on a cap-and-trade principle, the ETS sets a declining cap on total emissions from covered installations, while allowing companies to trade emission allowances among themselves. This market mechanism creates a financial incentive for emission reductions where they are most cost-effective, driving decarbonisation across the European economy.

ETS Phase IV, running from 2021 to 2030, significantly tightened the system following the Fit for 55 legislative reforms. The annual reduction factor for the emissions cap was increased to 4.3% from 2024 and 4.4% from 2028, accelerating the path toward the EU's target of at least 55% emissions reduction by 2030. The system now covers approximately 10,000 installations in power generation, manufacturing, and intra-EEA aviation, and a new ETS II for buildings, road transport, and small industry was established to begin in 2027.

Covered operators must monitor and report their verified annual emissions, then surrender a corresponding number of EU Allowances (EUAs). Allowances are distributed through a combination of auctioning and free allocation, with free allocation being gradually phased out for sectors covered by CBAM. Companies that reduce emissions below their allocation can sell surplus allowances on the carbon market, while those exceeding their allocation must purchase additional allowances or face penalties of 100 euros per excess tonne, adjusted for inflation.

The interaction between the ETS and the Carbon Border Adjustment Mechanism is particularly significant. As CBAM comes into full effect from 2026, free allocation under the ETS for CBAM-covered sectors will be progressively reduced, ensuring a smooth transition from border-free carbon pricing within the EU to a system where both domestic producers and importers face equivalent carbon costs. This alignment is designed to maintain competitive fairness while preventing carbon leakage.

For businesses, the ETS represents both a compliance cost and a strategic opportunity. Companies that invest in low-carbon technologies and energy efficiency can generate value through reduced allowance purchases or surplus sales. The system's interaction with the EU Taxonomy helps companies demonstrate that their investments and activities contribute to climate mitigation objectives, reinforcing the connection between carbon market compliance and sustainable finance.

Select your company type for tailored compliance guidance.